Stocks — Part X: What if Vanguard gets Nuked?

Posted: September 7, 2012 in Stock Investing Series

You don’t have to read very far into this blog to know I am a strong proponent of investing in Vanguard index funds.  Indeed, you’ll find this in the Manifesto:

Vanguard.  End of story.

Understandably, this raises some questions.  Today let’s look at the four most common:

1.  What makes Vanguard so special?

When Jack Bogle founded Vanguard in 1975 he did so with a structure that remains unique in the investment world:  Vanguard is client-owned and it is operated at-cost.

Sounds good, but what does it actually mean?

As an investor in Vanguard Funds, your interest and that of Vanguard are precisely the same.  The reason is simple.  The Vanguard Funds, and by extension the investors in those funds, are the owners of Vanguard.

By way of contrast, every other investment company has two masters to serve:  The company owners and the investors in their funds.  The needs of each are not always, or even commonly, aligned.

To understand the difference, let’s look at how other investment companies (most companies in fact) are structured.  Basically, there are two options:

1.  They can be owned privately, as in a family business.  Fidelity Investments is an example.

2.  They can be publicly traded and owned by shareholders.  T. Rowe Price is an example.

In both cases the owners understandably expect a return on their investment.  This return comes from the profits each company generates in operating its individual mutual funds.   The profits are what’s left over after the costs of operating the funds are accounted for — things like salaries, rent, supplies and the like.

Serving the shareholders in their funds is simply a means to generate this revenue to pay the bills and create the profit that pays the owners.  This revenue comes from the operating fees charged to shareholders in each of their individual funds.

When you own a mutual fund thru Fidelity or Price or any investment company other than Vanguard, you are paying for both the operational costs of your fund and for a profit that goes to the owners of your fund company.

If I am an owner of Fidelity or Price I want the fees, and resulting profits, to be as large as possible.  If I am a shareholder in one of their funds, I want those fees to be as modest as possible.  Guess what?  The fees are set as high as possible.

Now to be clear, there is nothing inherently wrong with this model.  In fact it is the way most companies operate.

When you buy an iPhone built into the price are all the costs of designing, manufacturing, shipping and retailing that phone to you.  Along with a profit for the shareholders of Apple.  Apple sets the iPhone price as high as possible, consistent with costs, profit expectations and the goal of selling as many as they can make.  So, too, with an investment company.

In this example I chose Fidelity and Price not to pick on them.  Both are excellent operations with some fine mutual funds on offer.  But because they must generate profit for their owners, both are at a distinct cost disadvantage to Vanguard.  As are all other investment companies.

Bogle’s brilliance, for us investors, was to shift ownership of his new company to the mutual funds it operates.  Since we investors own those funds, thru our ownership of shares in them, we in effect own Vanguard.

Any profits generated by the fees we pay would find their way back into our pockets.  Since this would be a somewhat silly and roundabout process and, more importantly, since it would potentially be a taxable event, Vanguard was structured to operate “at cost.”  That is, with the goal charging only the minimum fees needed to cover the costs of operating the funds.

What does this translate into in the real world?

Such fees are reported as “expense ratios.”  The average expense ratio at Vanguard is .20%.  The industry average is 1.12%.  Now this might not sound like much, but over time the difference is immense and it is one of the key reasons Vanguard enjoys a performance as well as a cost advantage.

With Vanguard, I own my mutual funds and thru them Vanguard itself.  My interests and those of Vanguard are precisely the same.  This is a rare and beautiful thing, unique in the world of investing.

Click on the quote below for more:

“No one, other than the funds and their shareholders, owns a piece of Vanguard. Nobody. Our CEO, Bill McNabb, and even our founder, Jack Bogle, are client-owners in exactly the way you are.”

2.  Why are you comfortable having all your assets with one company?  Isn’t this what tanked investors with Bernie Madoff?

Because my assets are not invested in Vanguard.  They are invested in the Vanguard Mutual Funds and, thru those, invested in the individual stocks, bonds and REITS those funds hold.  Even if Vanguard were to implode (a vanishingly small possibility), the underling investments would remain unaffected.  They are separate from the Vanguard company.  As with all investments, these carry risk, but none of that risk is directly tied to Vanguard.

Now this can start to get very complex and for the very few of you who care, there’s lots of further info you can easily Google.  For our purposes here, what’s important to know is:

1.  You are not investing in Vanguard, you are investing in one or more of the mutual funds it manages.

2.  The Vanguard mutual funds are held as separate entities.  Their assets are separate from Vanguard, they each carry their own fraud insurance bonds, each has its own board of directors charged with keeping an eye on things.  In a very real sense, each is a separate company operated independently but under the umbrella of Vanguard.

3.  No one at Vanguard has access to your money and therefore no one at Vanguard can make off with it.

4.  Vanguard is regulated by the SEC.

All of this, by the way, is also true of other mutual fund investment companies, like Fidelity and Price.  Those offered in your 401k are, in all likelihood, just fine too.  (If you have an employer sponsored retirement plan, like a 401k, that doesn’t offer Vanguard funds by all means invest in it anyway.  Especially if any company match contributions are offered.  Those are free money and an instant return on your investment.)

It is NOT true however for what are called Private Investment Funds.  Those are where you turn your money over directly to an individual or group of individuals to manage and invest.  That’s what Madoff was running.

3.  What if Vanguard gets nuked?

Ok, let’s be clear.  If the world ends on December 21, 2012 as evidently the Mayan Calendar suggests it might, everything you have invested in Vanguard (or elsewhere) will go up in smoke.  But that’s not gonna happen. (Come December 22nd, I’m putting “told you so” right here.)

If a giant meteor slams into Earth setting the world on fire followed by a nuclear winter, your investments are toast.

If space aliens arrive and enslave us all, unless you bought human feedlot futures, it’s gonna mess up your portfolio.

If super volcanos or global warming or viruses or an ice age or the reversal of the magnetic poles or AI robots or nanobots or maybe Zombies take us out, investing with Vanguard will be of no help at all.

Relax.  It ain’t none of it gonna happen.  At least not on our watch.

But lesser disasters can and do happen.  Vanguard is based in Malvern, Pennsylvania.  What if, God forbid, Malvern is nuked in a terrorist attack?  What about a cyber attack?  Hurricane?  Pandemic? Power outage?

Every major company and institution is aware of these dangers and each has created a Disaster Recovery Plan.  Vanguard has one of the most comprehensive going.  The company is spread across multiple locations.  Its data is held in multiple and redundant systems.  You can check out their plan here:  Business Recovery Plan

But, if you are expecting a planet or even just a civilization ending event, Vanguard’s not for you.  But then, no investments really are.  You’re already stocking your underground shelter with canned goods.  Short of that, you can sleep just fine with your assets at Vanguard.  I do.

4.  Am I on the take?

This blog is such strong a proponent of Vanguard it is reasonable to ask….

“Am I on the take?”

Nope.  Vanguard doesn’t know I’m writing this and they are not an advertiser.  Nor do they pay me in any fashion whatsoever.

In fact, at the moment, I have no paid advertising on this blog.  Maybe someday.

(However,  I understand that you might occasionally see an ad here.  Those are placed by WordPress.  I never see them on my pages.  I don’t know if, when or for who they run.  I do know that’s how WordPress is able to offer me this blog hosting at no charge.  And, for now, I’m OK with that.)

For my International readers — an Addendum:  With its client centered focus, Vanguard is growing rapidly and now is available in many countries outside the USA.  You can check the list out here:  Vanguard Global

 

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Comments
  1. […] Stocks — Part X: What if Vanguard gets Nuked? […]

  2. […] Stocks — Part X: What if Vanguard gets Nuked? […]

  3. […] Stocks — Part X: What if Vanguard gets Nuked? @ Jlcollinsnh […]

  4. Malaika says:

    Jim, Great writing and an interesting article. Thank you for taking the time to share this information especially for “dummies like me”. Very much appreciated and a very easy read .

  5. […] Get Rich Slowly – Index Funds: The Investment Answer? Mr. Money Mustache – How to Make Money in the Stock Market JL Collins NH – What if Vanguard Gets Nuked […]

    • jlcollinsnh says:

      Hey Mad F….

      Thanks for linking to this post. That got me poking around your site a bit.

      I especially enjoyed your interview with Mr. MM. So that’s what he sounds like! :)

      http://www.madfientist.com/mr-money-mustache-interview/

      • Mad Fientist says:

        Hi Jim,

        Thanks for writing such a great post to link to!

        I’m glad you enjoyed the interview with Mr. Money Mustache. It was a lot of fun talking to him; he’s a great guy so speaking to him was just as enjoyable as reading his articles.

        Speaking of the podcast…I was actually planning on getting in touch soon to see if you’d be interested in being interviewed for a future episode of the Financial Independence Podcast? I’m a big fan of your writing so I’d love hear more about your journey to FI. If you’re interested, please email me and we can talk more about it!

        Thanks again for the great post and hopefully I’ll hear from you again soon!

        – Mad Fientist

  6. ChetBodet says:

    So question for you,

    I am a young guy, 24, looking to start saving more towards financial independence. What is the best option to buy Vanguard funds if I want to have access to them before the minimum withdrawal age set on IRAs? I already have a Roth IRA and am currently at a company that does not offer a 401K plan. Any advice would be incredibly appreciated.

    • jlcollinsnh says:

      Hi Chet….

      If I understand your question correctly, it’s pretty simple:

      Just open a regular (non IRA) account. You can buy any fund outside an IRA and have penalty free access anytime.

      Of course, assuming you are here in the USA, you will owe taxes on any capital gains and/or dividend the fund pays and, if you sell shares at a profit, you will owe a tax on capital gain.

      Funding your Roth first is a good move.

      congrats on getting an early start!

      • ChetBodet says:

        As far as tax implications go would it be better just to open the regular account or would it be worth it to consider opening an IRA and risk the early withdrawl penalties?

        • jlcollinsnh says:

          That depends on two things:

          1. How likely are you to withdraw this money early and incur the penalties. If you are planning, say, to buy a house and this is your downpayment money you want to avoid IRAs. If you are just thinking, OMG what if I get in trouble and need this cash, that’s something else.

          2. Are you in a high enough tax bracket to make the deduction worthwhile? Most 24-year-olds are not. Remember, IRAs (except ROTH) don’t eliminate your tax payments they only delay them until you pull the money out. I, for example, am now in a higher tax bracket retired than I was in my 20s.

  7. 101 Centavos says:

    Good writeup on Vanguard, Jim. Index investing is the safest way for most, although I feel people should also know how to do some basic valuation and understand the principles behind income statements and balance sheets.

    • jlcollinsnh says:

      Thanks 101….

      and you bring up an interesting point.

      Investing knowledge is something that interests you and me. I certainly agree that anyone planing to actively invest by picking individual stocks had better be able to do some basic valuation and understand the principles behind income statements and balance sheets.

      But even then, with vanishingly rare exception, they will underperform an index fund like VTSAX. Their effort and knowledge will actually end up costing them money.

      The second thing I’ve come to understand is the vast majority of people have zero interest in investing and certainly none in income statements and balance sheets. Yet these folks also want/need to be financially secure.

      The good news is that very successful investing can be had with very simple tools.

      This is the message and purpose of this blog.

  8. PFgal says:

    You and others have convinced me to switch to Vanguard. Now I just have to figure out the logistics, since I already have everything at Schwab. I think a phone call to Vanguard is in order….

    • jlcollinsnh says:

      Hi PFgal….

      you’ll find the folks there very helpful when you call. Of course you are also going to have to get Schwab to release your funds.

      I have no experience with them, but I do have a friend who recently switch from Merrill Lynch. Seems the folks at ML did everything they could to drag their feet and block the process.

      Any doubts she had about leaving them were dispelled by their behavior.

      hope your experience with Schwab is smooth and professional. please let us know.

  9. RW says:

    While I do have Vanguard in some of my 401k holdings. When I tried to roll over a Roth IRA into a Vanguard fund, I found that some of the funds are closed to new investors. In fact, some of your favorites you mention in earlier posts.
    Jack Bogle is certainly a pioneer in the investing world, I found the Bogleheads guide to investing to be a good read for the Jr. investor like myself. Wish I would have done this much early in life…
    Vanguard certainly has lower fees, more of your money working for you vs fees taking a cut of your cash. How do you feel about Reits? Also would like to hear your take on dividend investing? Seems to be an easy way to reap cash quarterly based on what I have read so far…
    From prior posts seems you are not a big fan.

    • jlcollinsnh says:

      Hi RW….

      There are four funds that meet all our investing needs and I describe them here: https://jlcollinsnh.wordpress.com/2011/06/14/what-we-own-and-why-we-own-it/

      Just did a quick check and all are still open to new investors. Which have you found closed?

      I do use, and link to, the Admiral version of these funds which have a lower expense ratio but a 10k investment minimum. However each also has an “Investor Shares” version and Vanguard provides links to those at the top of the page.

      One of the four funds I use is a REIT. Combined with the equity in my house it comprises 25% of my portfolio. Real Estate held this way in my inflation hedge.

      My concern with dividend investing is:

      1. It requires selecting individual stocks, a complex endeavor that almost always underperforms the Index.

      2. It focuses on only one of the ways companies produce value and return to shareholders.

      3. Dividends paid, outside a tax advantaged account, are taxable.

      That said a well executed dividend investment program will get you to FI. It’s just more work and less powerful than VTSAX. Here’s more: https://jlcollinsnh.wordpress.com/2011/12/27/dividend-growth-investing/

      • RW says:

        Thanks, I have not made the move to dividend investing. I am more of a set it and forget it kind of person. So the Index funds do meet my style. I will look again at the Admiral versions offered. Thanks again!

  10. Jan says:

    Excellent! This is your best ever, Jim. Thank you. I will sleep a little bit better tonight.

  11. Steve says:

    Nice to see you back off your holidays JLC, I like your clear explanation of all things financial and quit often link them on my facebook page but unfortunately most people don’t have my interest in finance and shares.
    But getting to your article and Vanguard (of which I am a fan) and the company structure seems to be very similar to a mutual society or Cooperative here in the UK.
    Now I had the pleasure of working for an old Cooperative http://www.co-operative.coop/corporate/aboutus/ourhistory/
    and actually its a very different atmosphere to any other company that I have worked for and it’s true that ethics and honesty was more important there than any other company.

    But I must worn that in a old mutual or cooperative where the original company creator has gone, sometimes they can get over bloated and inefficient (Vanguard is in it’s infancy compared to The Coop) and the guys at the top can sometimes become overpaid, old and less interested in the company and more interested in retiring.
    Now the Coop is making a comeback and is more efficient and has got some of it’s spark back but this has taken more than 10 years to do.
    When they made me redundant they informed us and said the depot was to be closed quickly and it took 3 years (and that is fast for the Coop).
    I am not saying this will ever happen to Vanguard but you have to keep your eyes open.

    • jlcollinsnh says:

      Thanks Steve, and thanks for linking some of this stuff on your facebook page. I always appreciate readers passing the blog along to their pals.

      wow. that’s some history in the link you provided.

      your concern about mission and value drift in organizations once a founder leaves is well worth consideration.

      When Jack Bogle stepped down as Vanguard’s CEO in 1996 it gave me pause and focused my attention. Since then there have been two more CEOs and the course and values remain rock solid. To a great extent the organizational structure locks them in and the core beliefs are deeply engrained. I’m not much worried.

      That said, were I to notice any drift I’d shift into high alert. For now and the foreseeable future, while I’ll always keep an eye open, I sleep well at night.

  12. Shilpan says:

    Awesome thoughts, Jim! John Bogle is on a noble mission to save the world from insanity. I encourage your readers to read this article about this great man and his priceless advice.

    http://www.nytimes.com/2012/08/12/business/john-bogle-vanguards-founder-is-too-worried-to-rest.html?_r=1&pagewanted=1&hpw

    • jlcollinsnh says:

      Thank you, my friend.

      Mr. Bogle has done more for the individual investor than anyone else in history. He is my personal hero and I only wish I’d found Vanguard and Indexing sooner.

  13. Eric says:

    Sir,

    In fact, Vanguard is based in Malvern, Pennsylvania
    https://en.wikipedia.org/wiki/The_Vanguard_Group

    • jlcollinsnh says:

      Doh!

      I stand corrected. You are absolutely right. Man, I need a fact checker.

      Although, in my defense, they do have an operation in Baltimore.

      T. Rowe Price is the one in Baltimore. And Fidelity is in Boston.

  14. Really enjoyed the article! I’m thinking of investing one of our ROTH IRAs with them. Still trying to figure it out.

    • jlcollinsnh says:

      Thanks SFL….

      Good luck with your Roth decision, and just deciding to have a Roth is a great decision. :)

      • Thanks :) The pf atmosphere is how I got introduced to the ROTH IRA. Surprisingly, no one including my in laws who are well educated talk about choosing retirement funds.

        • jlcollinsnh says:

          Sadly, I’m not surprised.

          Investing was never a part of my formal education either. My daughter had one class in high school and nothing, so far, in college.

          the world is filled with highly educated folks lost in the financial wilderness….

          • Personal finance is not a priority in formal education. Hah, even WSJ and Bloomberg have a crappy personal finance section. The best advice comes from reading lots of pf bloggers.
            I took lots of classes in finance, and only a couple professors mentioned stocks, but never really talked about how to get started, the advantages, etc.

  15. Julie says:

    You write about the Vanguard Mutual Funds. Does the same apply to their ETF’s or are their further risks with these.

    • jlcollinsnh says:

      Great question, Julie. The short answer is: Yes, my comments about the mutual funds also apply to the ETFs. That said, given the choice, I prefer the funds.

      First, ETF stands for Exchange Traded Fund. Basically these are mutual funds that you can buy and sell just like individual stocks. Here’s why the people who like them like them:

      1. If you live outside the USA, the ETF versions may be the only way you can buy Vanguard funds. If this is the case, by all means go ETF.

      If you go to Vanguard’s site and look up a fund, say VTSAX, directly under the name of the fund you’ll see a line with links indicating it is available as an ETF.

      2. When you buy or sell a mutual fund your trade is executed at the end of the business day. With ETFs, like stocks, it is executed immediately. If you are a short term trader, this is important.

      Here’s why I don’t use them:

      1. If you are a long term investor #2 above is of no consequence. Since short term trading is an always dangerous and most often losing game, I avoid it.

      2. Buying or selling an ETF most often involves paying a brokerage commission. I don’t like extra expenses.

      3. Living in the USA I don’t need ETFs. I can easily buy the mutual fund versions.

  16. Beautifly written as always, and very informative. I love Vanguard, but I am also one of those who does not invest ALL my money with them. I understand the risks (and much better now, thank you), but I while I am sure that majority of the money invested with them would be returned eventually, if they were to implode, I still worry about how much time and effort would that take.

    And yes, to illustrate how “management fees” impact the mutual funds and investments in general, I did a spreadsheet last year (because financial firms do not give you that information easily), and I found out the in the 10 years my company and I were contributing into Great West Life (Canadian Company) employer sponsored retirement fund, fund managers made more money on my money than me. They made about 2% return over 10 years, I made only 1.6% average return. I would love to dump them, but when company copays $1 for each $1 that I contribute (up to a certain level), and I get to defer taxes until retirement (RRSP), I am getting at least 100% return on my money instantly :)

    • jlcollinsnh says:

      Thank you sir! Always nice to see you here. You make a couple of very important points.

      I should have pointed out (and in fact will edit the post to add) that the odds of Vanguard imploding are vanishingly small. Certainly small enough not to be a factor in my choice of investments. Further, since only long-term money should be invested waiting a few months if the unthinkable should happen is not a problem. I keep cash on hand for immediate needs.

      Great illustration of the impact of fees on returns, but even more important is your excellent point about employer sponsored retirement funds; what we call 401k here in the USA.

      Unfortunately, few of these plans offer Vanguard funds as an option. When I was working mine didn’t. But, as much as I love Vanguard, if your company offers such a program with a contribution match, GO FOR IT!

      This is the reason in #2 in my post I have the line: “All of this, by the way, is also true of other mutual fund investment companies, like Fidelity and Price. Those offered in your 401k are, in all likelihood, just fine too.”

      I should have been clearer. Mmmm. Think I’ll edit and add this point too.

  17. Kevin says:

    I was just trying to explain to my wife the benefits of Vanguard last night but I could not articulate it very well! Perfect timing with this article, thanks!

  18. Trisha Ray says:

    As always – nice and clear. Questions we hesitate to ask for fear of sounding stupid. Thanks!

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